Volume 4— Credit Risk Management © Copyright 2002, CCRO. All rights reserved. 10 collateral thresholds provisions. Many companies have added margining provisions to these form contracts and any desire to margin under the GISB or NAESB would have to be appropriately documented. Should trading begin before the relationship has been fully documented, a long-form confirmation must be used. Long-form confirmations should include the majority of the credit terms necessary to actively manage credit risks (see Section 2.0 for discussion of provisions). One of the limitations of long-form confirmations is that the counterparty signs the confirmation after the trade is done. Thus, the risk exists that the credit provisions associated with the trade are materially changed by the counterparty and may not be enforceable should the confirmation not be executed. In addition, to achieve desired netting and close-out provisions, the appropriate language must be incorporated within the long-form confirmation and/or a separate document that captures the appropriate language. While the legal department should be responsible for the overall format and content (excluding credit terms) of long-form confirmations, the credit department should have the ultimate authority for approving their use. 2.0 Contract/Credit Provisions In documenting any transaction, a best practice is to carefully consider each of the following points. • Is MTM exposure marginable? • Are delivered physical products marginable? • What types of collateral are acceptable? • How is posted margin managed? Commingled funds or segregated? • Other rules and procedures for margining (i.e., timing dispute resolution)? • What type of netting provisions? Monthly payment netting, close-out netting, or both? • Are termination rights defined? Termination payment calculation? Credit Thresholds Contractual arrangements should allow for margining of both MTM and accounts receivable (delivered and billed, and delivered and unbilled). Physical gas agreements should incorporate credit terms and provisions similar to the ISDA and/or the EEI. The language used to set a dynamic credit threshold based upon current credit condition can be classified into three groups: financial covenants and material adverse change (MAC) clauses, rating triggers, and adequate assurance clauses. Financial Covenants: Financial covenants include provisions that require counterparties to maintain certain financial ratios (such as total debt to total capital, EBIT/interest coverage, or FFO/total debt) in order to maintain unsecured credit. While these clauses provide objective criteria that can be defined and measured on a regular basis, it is exceedingly difficult to define all financial covenants that will capture each counterparty’s stress scenario. Moreover, these